Question

How we measure the risk?

• How we measure return?

• What is the difference between Average return and Geometric?

Answer 1

Risk is a measure of uncertainty. We measure risk by standard deviation most commonly. Another common measure is beta, which measures the systematic risk. Value at risk (VaR) is alao used to measure risk. Similarly, conditional VaR is also one method.

Return is measured in percentage terms. We yake into account income and gains over the period of holding. Cost is subtracted to get net income. Then we divide by cost to get regurn percentage.

Geometric return differs from average mean return in the sense that it takes into account the effects of compounding. Hence, investors most often use geometric return instead of average return which is simply the arithmetic average.

If in year one the return is 30% and in year 2 the return is 10%, then average return is 20% but geometric return is √(1.3*1.1) -1= 19.58%